Sunday, February 08, 2009

Enjoy low oil prices while you can

Henry Groppe, founder of Houston-based Groppe, Long & Littell, is 83 years old, a vegetarian and has been a forecaster in the oil and gas business since 1955. And he is not afraid to go against the conventional wisdom. One year back he predicted the oil price would collapse in the second half of the year -- and not reach the much talked-about price of US$200 a barrel.

Now Groppe, a special advisor to the Toronto-based Middlefield group of companies, has done his analysis and concluded that between now and year end the price of oil will double. If that forecast pans out, oil will hit US$80 a barrel, or more than double what others are predicting. His advice to consumers: Enjoy the current low gas prices, because they won't last for much longer.

"Given enough time, it's the fundamentals of supply and demand balances that control the price," Groppe said. "It's just like journalism: 'Get your facts straight,' " he said, when referring to moves inside the 80-million-barrel-a-day global oil business.

He bases his 2009 consumption forecast relative to 2008 on three such factors: the two-million-a-day barrel cut in production from OPEC, the bulk of which will come from three countries (Saudi Arabia, Kuwait and Abu Dhabi); the four-million-barrel-a-day increase in demand that will result from the average 50% decline in the crude oil price; and the 1.2 million barrel drop in consumption that will flow from the global recession. Put them all together and what emerges is a 4.8-million-barrel-a-day net oil shortage.

"There has to be a big upward correction in prices to bring things back into balance," Groppe said.

Groppe pointed out that two of the factors are dynamic, meaning that so-called demand elasticities are associated with them: a 0.1 elasticity between price and demand and a 0.3 elasticity between price and world growth.

Overall, the reduced consumption effect of the global recession, while large, will be more than offset by the effect of the lower price.

"[The significant] price change, because there is so much volatility, has much more impact on oil price than economic activity," he said.

Groppe said cutbacks by OPEC, unusually cold weather and China driving up the price of distillate (because of a plan to substitute for coal) explain all but US$25-US$30 per barrel of 2008's peak-oil price. He puts the rest of the gain down to the actions of "momentum traders. They piled on," he said, noting the current price is about US$20 a barrel lower than what fundamentals would dictate.

The veteran forecaster said "depletion and rational exploration" are the two most important "controlling fundamentals" in the oil industry. He argues that depletion gets underway when production from a new well starts while explorers are focused on finding the biggest discoveries. Groppe isn't impressed with much of the analysis done by governments, agencies or companies.

"The big problem is the terrible quality of the data. Do it long enough over the years, you get some feel for what the actual [supply and demand] balances are." But you have to try and pin down what's actually happening versus the misperception of what's happening," he said.

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